1
CIRCULAR NO. 3/2006
EXPLANATORY NOTES ON THE PROVISIONS OF
THE FINANCE ACT, 2005
F. NO. 153/120/2005-TPL
GOVERNMENT OF INDIA
MINISTRY OF FINANCE
DEPARTMENT OF REVENUE
CENTRAL BOARD OF DIRECT TAXES
New Delhi, the 27th February, 2006
Subject: -Finance Act, 2005 – Explanatory Notes on provisions relating to Direct Taxes (other than Banking Cash Transaction Tax and Fringe Benefit Tax).
1.Introduction
The Finance Act, 2005 (hereafter referred to as the Act) as passed by the Parliament, received the assent of the President on the 13th May, 2005 and has been enacted as Act No. 18 of 2005. The Act, in the field of Direct Taxes, has, -
(i)specified the rates of income-tax for the assessment year 2005-06 and the rates of income-tax on the basis of which tax has to be deducted and advance tax has to be paid during Financial Year 2005-06;
(ii)amended sections 2, 10, 10A, 16, 17, 32, 33AC, 35, 35DDA, 36, 40, 43, 47, 49, 54EC, 54ED, 73, 80CCC, 80CCD, 80-IA, 80-IB, 88, 112, 115A, 115JAA, 115VD, 119, 124, 139, 139A, 140, 140A, 142, 153, 153B, 153C, 194A, 194C, 199, 203, 206C, 238, 239, 244A, 246A, 271, 272A, 273B, 276CC, 278 and 295 of the Income-tax Act, 1961;
(iii)inserted new sections 72AA, 80C, 80CCE, 206A, 271FB and Chapter XII-H in the Income-tax Act, 1961;
(iv)omitted sections 80L, 88B, 88C and 88D of the Income-tax Act, 1961;
(v)substituted new section for section 80E of the Income-tax Act;
(vi)amended section 98 of the Finance (No.2) Act, 2004; and
(vii)introduced a new levy namely, Banking Cash Transaction Tax
Provisions relating to Banking Cash Transaction Tax introduced through Chapter VII of the Act along with consequential amendments in the Income-tax Act, 1961 have been explained separately through Circular No. 03/2005 dated 3rd June, 2005. Similarly, the provisions relating to Fringe Benefit Tax introduced through Chapters XII-H of the Income-tax Act, 1961 have been explained separately through Circular No.8/2005 dated 29th August, 2005. This circular explains the substance of other provisions of the Act relating to Direct Taxes.
2.RATE STRUCTURE
2.1Rates of income-tax in respect of incomes liable to tax for the assessment year 2005-2006.
2.1.1In respect of incomes of all categories of tax payers (corporate as well as non-corporate) liable to tax for the assessment year 2005-2006, the rates of income-tax have been specified in Part I of the First Schedule to the Act.
2.1.2The rates specified in Part I of the First Schedule to the Act are the same as those laid down in Part III of the First Schedule to the Finance (No. 2) Act, 2004 for the purposes of computation of "advance tax", deduction of tax at source from "Salaries" and charging of tax payable in certain cases during the financial year 2004-2005.
2.1.3Surcharge –
(i) In the case of individuals, Hindu undivided families, association of persons and body of individuals having total income exceeding Rs. 8,50,000/-, the tax so computed after rebate under Chapter VIII-A, shall be enhanced by a surcharge of ten per cent. for purposes of the Union.
(ii)In case of a firm, a local authority and a co-operative society, the tax computed shall be enhanced by a surcharge of two and one-half per cent.
(iii)In the case of every artificial juridical person other than cooperative society, firm, local authority and company, the tax computed shall be enhanced by a surcharge of ten per cent.
(iv)In case of a domestic company, the tax computed shall be enhanced by a surcharge of two and one-half per cent.
(v)In case of a foreign company, the tax computed shall be enhanced by a surcharge of two and one-half per cent.
2.2.1Education Cess - An additional surcharge called the Education Cess is to be levied at the rate of two per cent. on the amount of tax computed, inclusive of surcharge if any. For instance, if the income-tax computed is Rs. 1,00,000/- and the surcharge is Rs. 10,000/-, then the education cess of two per cent. is to be computed on Rs. 1,10,000/- which works out to be Rs. 2,200/-.
2.2Rates for deduction of income-tax at source during the financial year 2005-2006 from income other than "Salaries".
2.2.2The rates for deduction of income-tax at source during the financial year 2005-2006 from incomes other than "Salaries" have been specified in Part II of the First Schedule to the Act. Rates for deduction of income-tax at source from income other than salaries will continue to be the same as those specified in Part II of the First Schedule to the Finance (No.2) Act, 2004 except that the rate for deduction of tax at source on payment of royalty or fees for technical services to a foreign company in pursuance of an agreement made by such company with the Government or an Indian concern on or after the 1st day of June, 2005 has been reduced from twenty per cent. to ten per cent.
2.2.3The tax deducted at source in each case shall be increased by a surcharge for purposes of the Union as follows:
(i)in the case of every individual, Hindu undivided family, association of persons and body of individuals, at the rate of ten per cent. of such tax where the income or the aggregate of such incomes paid or likely to be paid and subject to deduction exceeds Rs.10,00,000/-;
(ii)in the case of every firm, at the rate of ten per cent. of such tax;
(iii)in the case of every artificial juridical person, at the rate of ten per cent. of such tax;
(iv)in the case of every domestic company, at the rate of ten per cent. of such tax; and
(v)in the case of every foreign company, at the rate of two and one-half per cent. of such tax.
2.2.4No surcharge is to be levied on the amount of income tax deducted in the case of every co-operative society and local authority.
2.2.5Education Cess - An additional surcharge called the Education Cess is to be levied at the rate of two per cent. on the amount of tax deducted, inclusive of surcharge if any. For instance, if the income-tax computed is Rs. 1,00,000/- and the surcharge is Rs. 10,000/-, then the education cess of two per cent. is to be computed on Rs. 1,10,000/- which works out to be Rs. 2,200/-.
2.3Rates for deduction of income-tax at source from "Salaries", computation of "advance tax" and charging of Income-tax in special cases during the financial year 2005-2006.
2.3.1The rates for deduction of income-tax at source from "Salaries" during the financial year 2005-2006 and also for computation of "advance tax" payable during that year in the case of all categories of tax payers have been specified in Part III of the First Schedule to the Act. These rates are also applicable for charging income-tax during the financial year 2005-2006 on current incomes in cases where accelerated assessments have to be made, e.g., provisional assessment of shipping profits arising in India to non-residents, assessment of persons leaving India for good during that financial year, assessment of persons who are likely to transfer property to avoid tax, or assessment of bodies formed for short duration, etc.
2.3.2The salient features of the rates specified in the said Part III are indicated in the following paragraphs:-
2.3.3Individuals, Hindu undivided families, etc.
Paragraph A of Part III of the First Schedule specifies the rates of income-tax in the case of individuals, Hindu undivided families, association of persons, body of individuals or artificial juridical persons other than a co-operative society, firm, local authority and company and are given as under :-
Income chargeable to tax / Rateindividual (other than women and senior citizens), HUF, association of persons, body of individuals and artificial juridical person / woman, resident in India and below the age of sixty-five years / senior citizen, resident in India, who is of the age of 65 years or more
Upto Rs. 1,00,000 / Nil / Nil / Nil
Rs. 1,00,001 – Rs. 1,35,000 / 10%
Rs. 1,35,001 – Rs. 1,50,000 / 10%
Rs. 1,50,001 – Rs. 1,85,000 / 20% / 20%
Rs. 1,85,001 – Rs. 2,50,000 / 20%
Exceeding Rs. 2,50,000 / 30% / 30% / 30%
2.3.4The tax payable would be enhanced by a surcharge for the purposes of the Union at the rate of ten per cent. of the tax payable (after allowing rebate under Chapter VIII-A) in cases of individuals, Hindu undivided families, association of persons, body of individuals having total income exceeding Rs.10,00,000/-. No surcharge would be payable by persons having incomes of Rs.10,00,000/- or below. Marginal relief would be provided to ensure that the additional amount of income-tax payable, including surcharge, on the excess of income over Rs.10,00,000/- is limited to the amount by which the income is more than Rs.10,00,000/-. For instance, the amount of tax and surcharge on a total income of Rs. 10,20,000 calculated at the rates specified would have been Rs. 2,56,000 and Rs. 25,600 totaling to Rs. 2,81,600. The additional tax liability, as per this computation, incurred as compared to a person having a total income of Rs. 10,00,000 is Rs. 31,600. However, additional income as compared to a person having a total income of Rs. 10,00,000 is only Rs. 20,000. Therefore, a marginal relief is given to the extent of Rs. 11,600 in this case thereby providing that the additional tax liability cannot be more than the additional income. The total tax liability in this case will, therefore, be Rs. 2,76,000.
2.3.5In the case of every artificial juridical person (other than a co-operative society, firm, local authority and company), surcharge would be levied at ten per cent. of the income-tax payable on all levels of income.
2.3.6Education Cess - An additional surcharge called the Education Cess, is to be levied at the rate of two per cent. on the amount of tax deducted or advance tax paid, inclusive of surcharge if any. Computation of Education Cess is to be done as per the numerical illustration given in para 2.2.4. No marginal relief shall, however, be available in respect of the Education Cess.
2.3.7Co-operative societies - In the case of co-operative societies, the rates of income-tax have been specified in Paragraph B of Part III of the First Schedule to the Act. The rates are the same as that specified in the corresponding Paragraph of Part I of the First Schedule to the Act. No surcharge is to be levied on the income tax and only an additional surcharge called Education Cess is to be levied at 2% on the tax.
2.3.8Firms - In the case of firms, the rate of income-tax has been specified in Paragraph C of Part III of the First Schedule to the Act. The rate has been reduced to 30 per cent. Surcharge is to be levied at the rate of 10 per cent. on the income-tax and an additional surcharge called Education Cess is to be levied at 2% on such tax and surcharge.
2.3.9Local authorities - In the case of local authorities, the rate of income-tax has been specified in Paragraph D of Part III of the First Schedule to the Act. This rate is 30 % and is the same as that specified in the corresponding Paragraph of Part I of the First Schedule to the Act. No surcharge is to be levied on the income-tax and only an additional surcharge called Education Cess is to be levied at 2% on tax.
2.3.10Companies - In the case of companies, the rate of income-tax has been specified in Paragraph E of Part III of the First Schedule to the Act.
The rate in the case of domestic companies has been reduced to 30 per cent. In the case of foreign companies the rate of tax on royalties received from Government or an Indian concern in pursuance of an agreement made by it with the Government or Indian concerned after 31.03.1961 but before 01.04.1976 will continue to be 50 per cent. The rate of tax for foreign companies on fees for rendering technical services received from Government or an Indian concerned in pursuance of an agreement made by it with the Government or the Indian concerned after 29.02.1964 but before 01.04.1976 will also continue to be 50 per cent. There is also no change in the existing rate of forty per cent on all other income for foreign companies. The tax payable by domestic companies would be enhanced by a surcharge at the rate of ten per cent. of the tax payable and in the case of foreign companies tax payable would be enhanced by a surcharge at the rate of two and one-half per cent. of the tax payable. The additional surcharge called Education Cess is to be levied at 2% on tax and surcharge in case of all companies.
[Section 2 and First Schedule]
3. AMENDMENTS TO SECTIONS OF THE INCOME TAX ACT
3.1Revival of exemption of interest in Non-Resident (External) Account - Section 10(4) (ii) of the I. T. Act deals with exemption of any income by way of interest on moneys standing to the credit of an individual in a Non-Resident (External) Account in any bank in India. Finance (No. 2) Act, 2004 had amended the said section so as to provide that such interest income paid or credited on or after 01-04-2005 shall not qualify for exemption. Section 4 of the Finance Act, 2005 has amended the said section so as to revive the exemption of such interest income for the period on or after 1st April, 2005.
Applicability: From A.Y. 2006-07 onwards.
[Section 4]
3.2Revival of exemption of interest on Foreign Currency Deposits - Section 10(15)(iv)(fa) of the I. T. Actdeals with exemption of any income payable by way of interest to a non-resident or to a person who is not ordinarily resident on deposits in foreign currency where the acceptance of such deposits by the bank is approved by the Reserve Bank of India. Finance (No. 2) Act, 2004 had amended the said section so as to provide that such interest income payable on or after 01-04-2005 shall not be exempt. Section 4 of the Finance Act, 2005 has amended the said section so as to revive the exemption of such interest income for the period on or after 1st April, 2005.
Applicability: From A.Y. 2006-07 onwards.
[Section 4]
3.3Revival of exemption on lease rentals paid while acquiring an aircraft or an aircraft engine - Section 10(15A) of the I. T. Act provides for an exemption from income-tax for lease payments received by the government of a foreign state or a foreign enterprise from an Indian company engaged in the business of operation of aircraft in respect of a lease of an aircraft or an aircraft engine by the said company. This exemption is available subject to the condition that the agreement for such lease is entered into prior to 1st April, 2005. In other words, the tax exemption is not available in respect of lease rent payments received under an agreement entered into on or after 1st April, 2005. Further, clause (6BB) of section 10 provides for exemption from tax on any tax paid by the Indian company on behalf of the government of a foreign state or a foreign enterprise in respect of such lease rent payments under an agreement entered into on or after 1st April, 2005.
The said clause (15A) was amended to provide that the exemption for lease payments shall continue with regard to agreements entered into on or before 30th September, 2005. The benefit of exemption from tax under clause (6BB) of section 10 will be available in respect of lease payments made in pursuance of agreements entered on or after 1st October 2005.
The Taxation Laws (Amendment) Act, 2005 has further amended clause (15A) of section 10 so as to provide the above-said exemption in respect of lease payments made in pursuance of agreements entered before the 1st day of April, 2006.
Applicability: From A.Y. 2006-07 onwards.
[Section 4]
3.4Filing of return mandatory for units in Special Economic Zones
Under the existing provisions of sub-section (1A) of section 10A, an undertaking set up in a Special Economic Zone, which begins to manufacture or produce articles or things or computer software after 31.3.2002, is allowed a hundred per cent. deduction of export profits for a period of five years followed by fifty per cent. deduction of such profits for the next two years, and thereafter a fifty percent deduction of export profits credited to a special reserve account, for the next three years.
In order to ensure timely submission of returns claiming deduction under section 10A, a proviso has been inserted to provide that no deduction shall be allowed with regard to profits of an undertaking set up in any Special Economic Zone and claiming deduction under sub-section (1A) of section 10A if the return of income is not furnished by the due date specified under sub-section (1) of section 139 of the Income-tax Act.
Applicability: From A.Y. 2006-07 onwards.
[Section 5]
3.5Elimination of Standard deduction for salaried tax payers.
Under the existing provisions of section 16, in computing the income under the head ‘Salaries’, an assessee whose income from salary does not exceed rupees five lakhs, is allowed a deduction of forty per cent. of salary or thirty thousand rupees, whichever is less. In the case of an assessee whose salary income exceeds rupees five lakhs, a deduction of rupees twenty thousand is allowed.
In view of the increase in the general exemption limit to rupees one lakh and the substantial broadening of the income slabs, clause (i) of the said section has been omitted, so as to withdraw the above benefits.
Applicability: From A.Y. 2006-07 onwards.
[Section 6]
3.6Enhancement of the rate of additional depreciation on new machinery and plant and withdrawal of certain conditions –
Under the existing provisions of clause (iia) of sub-section (1) of section 32, additional depreciation is allowed at the rate of fifteen per cent of the actual cost of the new machinery and plant (other than ships and aircraft) acquired and installed after the 31st day of March, 2002. Additional depreciation is allowed in the case of a new industrial undertaking during any previous year in which it begins to manufacture or produce any article or thing on or after the 1st day of April, 2002 or to any industrial undertaking existing before that date if it achieves substantial expansion during the previous year by way of increase in its installed capacity by not less than ten per cent.
In order to encourage investment, the Finance Act, 2005 has amended section 32 to increase the rate of additional depreciation to twenty per cent on new machinery and plant other than ships and aircraft, acquired and installed after the 31st day of March, 2005, and dispensed with the condition of additional depreciation to be allowed to a new industrial undertaking and the condition of expansion in installed capacity.
Depreciation rates have been modified through a Notification dated 28th February, 2005. The modified depreciation rates are effective from Assessment Year 2006-07. Among other things, the rate of depreciation on plant and machinery has been reduced from 25 % to 15 %.
Applicability: From A.Y. 2006-07 onwards.
[Section 8]
3.7Reserves to be added to profits and not the sale proceeds on sale of a ship
The existing sub-section (4) of section 33AC contains provisions dealing with the sale or transfer of a ship after the expiry of three years’ lock-in period. Where a company sells or transfers the ship after three years’ lock-in period and the sale proceeds are not utilised for the purpose of acquiring a new ship within a period of one year from the end of the previous year in which such sale or transfer took place, the sale proceeds are deemed to be the profits of the assessment year immediately following the previous year in which the ship was sold or transferred.
A new ship is acquired by a shipping company not only by utilising the reserves but also by resorting to loans and other finances. When a ship so acquired is sold or transferred, taxation of the whole of the sale proceeds would imply taxation of loans and other finances which has never been the intention. The legislative intention, in essence, has always been to tax only reserves utilised for acquiring the ship. The Finance Act, 2005 has amended the said sub-section (4) so as to provide that only so much of the sale proceeds which represent the amount credited to the reserve account and utilised for acquisition of the ship would be deemed as profits.